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Press release from PR Newswire

CP reports Q2-2014 net income of C$371M or C$2.11 per diluted share

Thursday, July 17, 2014

CP reports Q2-2014 net income of C$371M or C$2.11 per diluted share

07:30 EDT Thursday, July 17, 2014

Delivers strongest financial results in company's history

CALGARY, July 17, 2014 /PRNewswire/ - Canadian Pacific Railway Limited (TSX: CP) (NYSE: CP) today announced record Q2 2014 financial results.

Reported net income in the second quarter was $371 million, or $2.11 per diluted share, versus $252 million, or $1.43 per share, in the second quarter of 2013. This represents a 48 per cent year-over-year improvement in earnings per share.

SECOND-QUARTER 2014 RESULTS COMPARED WITH SECOND-QUARTER 2013:

  • Total revenues were $1,681 million, an increase of 12 per cent
  • Operating expenses were $1,094 million, an increase of 2 per cent
  • Operating income was $587 million, an increase of 40 per cent
  • Operating ratio was 65.1 per cent, a 680 basis point improvement

"CP delivered another record quarter," said E. Hunter Harrison, CP's Chief Executive Officer. "The team has made great strides in my two years at CP and they continue to demonstrate resiliency by delivering these results despite continued operational challenges in the US Midwest after a devastating winter. The future is very promising for the railroad as we transition towards leveraging our lower cost structure and improved service."

Note on forward-looking information This news release contains certain forward-looking information within the meaning of applicable securities laws relating, but not limited, to our operations, priorities and plans, anticipated financial performance, purchases of common shares for cancellation under CP's share repurchase program, future sources of capital, business prospects, planned capital expenditures, programs and strategies. This forward-looking information also includes, but is not limited to, statements concerning expectations, beliefs, plans, goals, objectives, assumptions and statements about possible future events, conditions, and results of operations or performance. Forward-looking information may contain statements with words or headings such as "financial expectations", "key assumptions", "anticipate", "believe", "expect", "plan", "will", "outlook", "should" or similar words suggesting future outcomes.

Undue reliance should not be placed on forward-looking information as actual results may differ materially from the forward-looking information. Forward-looking information is not a guarantee of future performance. By its nature, CP's forward-looking information involves numerous assumptions, inherent risks and uncertainties that could cause actual results to differ materially from the forward-looking information, including but not limited to the following factors: changes in business strategies; general North American and global economic, credit and business conditions; risks in agricultural production such as weather conditions and insect populations; the availability and price of energy commodities; the effects of competition and pricing pressures; industry capacity; shifts in market demand; changes in commodity prices; uncertainty surrounding timing and volumes of commodities being shipped via CP; inflation; changes in laws and regulations, including regulation of rates; changes in taxes and tax rates; potential increases in maintenance and operating costs; uncertainties of investigations, proceedings or other types of claims and litigation; labour disputes; risks and liabilities arising from derailments; transportation of dangerous goods; timing of completion of capital and maintenance projects; currency and interest rate fluctuations; effects of changes in market conditions and discount rates on the financial position of pension plans and investments; and various events that could disrupt operations, including severe weather, droughts, floods, avalanches and earthquakes as well as security threats and governmental response to them, and technological changes.  The foregoing list of factors is not exhaustive.

These and other factors are detailed from time to time in reports filed by CP with securities regulators in Canada and the United States.  Reference should be made to "Management's Discussion and Analysis" in CP's annual and interim reports, Annual Information Form and Form 40-F. Readers are cautioned not to place undue reliance on forward-looking information. Forward-looking information is based on current expectations, estimates and projections and it is possible that predictions, forecasts, projections, and other forms of forward-looking information will not be achieved by CP. Except as required by law, CP undertakes no obligation to update publicly or otherwise revise any forward-looking information, whether as a result of new information, future events or otherwise.

About Canadian Pacific Canadian Pacific (TSX:CP)(NYSE:CP) is a transcontinental railway in Canada and the United States with direct links to eight major ports, including Vancouver and Montreal, providing North American customers a competitive rail service with access to key markets in every corner of the globe. CP is growing with its customers, offering a suite of freight transportation services, logistics solutions and supply chain expertise. Visit www.cpr.ca to see the rail advantages of Canadian Pacific.

CANADIAN PACIFIC RAILWAY LIMITED

INTERIM CONSOLIDATED STATEMENTS OF INCOME      (in millions of Canadian dollars, except per share data) (unaudited)

        For the three months     For the six months
        ended June 30     ended June 30
        2014      2013      2014      2013 
Revenues                        
  Freight $ 1,642    $ 1,458    $ 3,116    $ 2,917 
  Other   39      39      74      75 
Total revenues   1,681      1,497      3,190      2,992 
Operating expenses                        
  Compensation and benefits   342      334      687      726 
  Fuel   273      246      544      516 
  Materials   47      35      99      79 
  Equipment rents   40      44      81      90 
  Depreciation and amortization   137      141      278      282 
  Purchased services and other   255      277      491      517 
Total operating expenses   1,094      1,077      2,180      2,210 
                           
Operating income   587      420      1,010      782 
Less:                        
  Other income and charges               11 
  Net interest expense    69      68      139      138 
Income before income tax expense   515      344      868      633 
                             
Income tax expense (Note 4)   144      92      243      164 
Net income $ 371    $ 252    $ 625    $ 469 
                           
                           
Earnings per share (Note 5)
  Basic earnings per share $ 2.13    $ 1.44    $ 3.57    $ 2.68 
  Diluted earnings per share $ 2.11    $ 1.43    $ 3.54    $ 2.66 
                             
Weighted-average number of shares (in millions) (Note 5)
  Basic   174.4      174.9      174.9      174.6 
  Diluted   175.9      176.3      176.5      176.1 
                             
Dividends declared per share $ 0.3500    $ 0.3500    $ 0.7000    $ 0.7000 
                             
Certain of the comparative figures have been reclassified in order to be consistent with the 2014 presentation. (Note 12)
See Notes to Interim Consolidated Financial Statements.

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in millions of Canadian dollars) (unaudited)

          For the three months     For the six months
        ended June 30   ended June 30
          2014      2013      2014      2013 
                             
                             
Net income $ 371    $ 252    $ 625    $ 469 
                             
  Net gain (loss) in foreign currency translation                       
    adjustments, net of hedging activities       (1)         (3)
                             
  Change in derivatives designated as cash flow hedges   (1)     (1)     (2)    
                             
  Change in defined benefit pension and post-retirement                       
    plans   31      61      62      249 
                         
  Other comprehensive income before income taxes   37    59      67    246 
                         
  Income tax expense   (24)   (1)     (16)   (41)
                         
Other comprehensive income (Note 3)   13    58      51    205 
                         
Comprehensive income $ 384    $ 310    $ 676    $ 674 
                         
See Notes to Interim Consolidated Financial Statements.                      

INTERIM CONSOLIDATED BALANCE SHEETS AS AT, (in millions of Canadian dollars) (unaudited)

      June 30   December 31
      2014    2013 
Assets                
Current assets                
  Cash and cash equivalents  $ 369   $ 476 
  Restricted cash and cash equivalents    402       411 
  Accounts receivable, net   687       580 
  Materials and supplies   174       165 
  Deferred income taxes   220       344 
  Other current assets   61       53 
        1,913     2,029 
                 
Investments    98       92 
Properties   13,538       13,327 
Assets held for sale (Note 6)       222 
Goodwill and intangible assets    162     162 
Pension asset   1,151       1,028 
Other assets    150       200 
Total assets $ 17,012   $ 17,060 
                     
Liabilities and shareholders' equity                    
Current liabilities                    
  Accounts payable and accrued liabilities $ 1,257   $ 1,189 
  Long-term debt maturing within one year (Note 8)   92     189 
        1,349      1,378 
                       
Pension and other benefit liabilities   660     657 
Other long-term liabilities   364     338 
Long-term debt (Note 8)   4,633     4,687 
Deferred income taxes   2,870     2,903 
Total liabilities   9,876       9,963 
                         
Shareholders' equity (Note 7)                    
  Share capital   2,248        2,240 
  Additional paid-in capital    34        34 
  Accumulated other comprehensive loss (Note 3)   (1,452)       (1,503)
  Retained earnings   6,306     6,326 
        7,136     7,097 
Total liabilities and shareholders' equity $ 17,012   $ 17,060 
                         
Contingencies (Note 11)                    
See Notes to Interim Consolidated Financial Statements.                  

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions of Canadian dollars) (unaudited)

          For the three months   For the six months
          ended June 30   ended June 30
            2014      2013      2014      2013 
Operating activities                      
  Net income $ 371    $ 252    $ 625    $ 469 
  Reconciliation of net income to cash provided by                      
  operating activities:                      
      Depreciation and amortization   137      141      278      282 
      Deferred income taxes (Note 4)   (15)     87      74      150 
      Pension funding in excess of expense (Note 10)   (33)     (14)     (65)     (23)
  Other operating activities, net     23      (21)     40      (19)
  Change in non-cash working capital balances related to                       
  operations    162      75      (20)     (72)
Cash provided by operating activities   645      520      932      787 
                               
Investing activities                      
  Additions to properties   (298)     (301)     (522)     (504)
  Proceeds from the sale of west end of Dakota, Minnesota                      
  and Eastern Railroad (Note 6)   236          236     
  Proceeds from the sale of properties and other assets   11      11      16      27 
  Change in restricted cash and cash equivalents used to                      
  collateralize letters of credit       (99)         (99)
  Other   (1)     (1)     (1)     (26)
Cash used in investing activities   (45)     (390)     (262)     (602)
                               
Financing activities                      
  Dividends paid   (62)     (60)     (123)     (121)
  Issuance of CP common shares   22      23      36      63 
  Purchase of CP common shares (Note 7)   (447)         (532)    
  Repayment of long-term debt   (11)     (7)     (154)     (26)
Cash used in financing activities   (498)     (44)     (773)     (84)
                               
Effect of foreign currency fluctuations on U.S. dollar-                      
denominated cash and cash equivalents   (12)         (4)    
Cash position                      
  Increase (decrease) in cash and cash equivalents   90      95      (107)     109 
  Cash and cash equivalents at beginning of period    279      347      476      333 
Cash and cash equivalents at end of period $ 369    $ 442    $ 369    $ 442 
                               
Supplemental disclosures of cash flow information:                      
  Income taxes paid  $ 30    $   $ 39    $ 11 
  Interest paid $ 88    $ 85    $ 160    $ 151 
                               
See Notes to Interim Consolidated Financial Statements.                      

INTERIM CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in millions of Canadian dollars, except common share amounts) (unaudited)

    Common           Accumulated        
    shares       Additional other     Total
    (in   Share paid-in comprehensive Retained shareholders'
    millions)   capital capital loss earnings equity
                           
Balance at January 1, 2014 175.4    $ 2,240  $ 34  $ (1,503) $ 6,326  $ 7,097 
Net income            625    625 
Other comprehensive income (Note 3)         51      51 
Dividends declared           (122)   (122)
Effect of stock-based compensation expense       11        11 
CP common shares repurchased (Note 7) (3.2)     (42)       (523)   (565)
Shares issued under stock option plans (Note 9) 0.6      50    (11)       39 
Balance at June 30, 2014 172.8    $ 2,248  $ 34  $ (1,452) $ 6,306  $ 7,136 
                           
                           
    Common           Accumulated        
    shares       Additional other     Total
    (in   Share paid-in comprehensive Retained shareholders'
    millions)   capital capital loss earnings equity
Balance at January 1, 2013 173.9    $ 2,127  $ 41  $ (2,768) $ 5,697  $ 5,097 
Net income            469    469 
Other comprehensive income (Note 3)         205      205 
Dividends declared           (124)   (124)
Effect of stock-based compensation expense       10        10 
Shares issued under stock option plans (Note 9) 1.1      86    (18)       68 
Balance at June 30, 2013 175.0    $ 2,213  $ 33  $ (2,563) $ 6,042  $ 5,725 
                           
See Notes to Interim Consolidated Financial Statements.          

CANADIAN PACIFIC RAILWAY LIMITED  NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS June 30, 2014 (unaudited)

1  Basis of presentation

These unaudited interim consolidated financial statements of Canadian Pacific Railway Limited ("CP", or "the Company"), expressed in Canadian dollars, reflect management's estimates and assumptions that are necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America ("GAAP"). They do not include all disclosures required under GAAP for annual financial statements and should be read in conjunction with the 2013 annual consolidated financial statements. The accounting policies used are consistent with the accounting policies used in preparing the 2013 annual consolidated financial statements.

CP's operations can be affected by seasonal fluctuations such as changes in customer demand and weather-related issues. This seasonality could impact quarter-over-quarter comparisons.

In management's opinion, the unaudited interim consolidated financial statements include all adjustments (consisting of normal and recurring adjustments) necessary to present fairly such information. Interim results are not necessarily indicative of the results expected for the fiscal year.

2 Future accounting changes

Reporting discontinued operations and disclosures of disposals of components

In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, an amendment to FASB Accounting Standards Codification ("ASC") Topic 205 and Topic 360. The update amends the definition of a discontinued operation in Topic 205, expands disclosure requirements for transactions that meet the definition of a discontinued operation and requires entities to disclose information about individually significant components that are disposed of or held for sale and do not qualify as discontinued operations. In addition, an entity is required to separately present assets and liabilities of a discontinued operation for all comparative periods and separately present assets and liabilities of assets held for sale in the initial period in which the disposal group is classified as held for sale on the face of the consolidated balance sheets. For each period in which assets and liabilities are separately presented on the consolidated balance sheets, those amounts should not be offset and presented as a single amount. This ASU will be effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2014, and will be applied prospectively. The adoption of this ASU is not expected to have a material impact to the Company's financial statements.

Revenue from contracts with customers

In May 2014, FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, a new FASB ASC, Topic 606, which supersedes the revenue recognition requirements in Topic 605 and most industry-specific guidance throughout the Industry Topics of the Codification. This new standard requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires enhanced disclosures about revenue to help users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This ASU will be effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2016. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt the ASU. The Company has not, at this time, ascertained the full impact on the consolidated financial statements from the adoption of this new standard but does not expect the impact to be material.

3  Changes in accumulated other comprehensive loss ("AOCL") by component

  For the three months ended June 30 For the six months ended June 30
(in millions of Canadian dollars) Foreign currency net of hedging activities(1) Derivatives and other(1) Pension and post- retirement defined benefit plans(1)(2) Total(1) Foreign currency net of hedging activities(1) Derivatives and other(1) Pension and post- retirement defined benefit plans(1)(2) Total(1)
                 
Opening balance, 2014 $ 122 $ (16) $ (1,571) $ (1,465) $ 105 $ (15) $ (1,593) $ (1,503)
                 
Other comprehensive income                
(loss) before reclassifications (8) (10) - (18) - - 9
                 
Amounts reclassified from                
accumulated other                
comprehensive loss (income) - 23  31  - (3) 45  42 
                 
Net current-period other                
comprehensive (loss) income (8) (2) 23  13  (3) 45  51 
                 
Closing balance, 2014 $ 114 $ (18) $ (1,548) $ (1,452) $ 114 $ (18) $ (1,548) $ (1,452)
                 
Opening balance, 2013 $ 82 $ (15) $ (2,688) $ (2,621) $ 74 $ (14) $ (2,828) $ (2,768)
                 
Other comprehensive income                
before reclassifications 12  10  30  20  15  102  137 
                 
Amounts reclassified from                
accumulated other                
comprehensive (income) loss - (9) 37  28  - (15) 83  68 
                 
Net current-period other                
comprehensive income 12  45  58  20  - 185  205 
                 
Closing balance, 2013 $ 94 $ (14) $ (2,643) $ (2,563) $ 94 $ (14) $ (2,643) $ (2,563)

      (1) Amounts are presented net of tax. (2) Reclassified from Accumulated other comprehensive loss.

Amounts in Pension and post-retirement defined benefit plans reclassified from Accumulated
other comprehensive loss
  For the three months   For the six months
  ended June 30   ended June 30
(in millions of Canadian dollars) 2014    2013    2014    2013 
                       
Amortization of prior service costs(1) $ (17)   $ (17)   $ (34)   $ (23)
Recognition of net actuarial loss(1)   48     70     96     137
                       
Total before income tax   31     53     62     114
Income tax recovery   (8)     (16)     (17)     (31)
Net of income tax $ 23   $ 37   $ 45    $ 83
(1) Impacts Compensation and benefits on the Consolidated Statements of Income.

4  Income taxes

  For the three months   For the six months
  ended June 30   ended June 30
(in millions of Canadian dollars) 2014    2013    2014    2013 
Current income tax expense  $ 159    $   $ 169    $ 14 
Deferred income tax expense (recovery)   (15)     87      74      150 
Income tax expense  $ 144    $ 92    $ 243    $ 164 

The effective income tax rate for the three and six months ended June 30, 2014 was 28% (three and six months ended June 30, 2013 - 27% and 26%, respectively). The lower rate in 2013 was primarily the result of a benefit recognized for a U.S. federal track maintenance credit of $6 million for 2012 enacted in the first quarter of 2013.

5  Earnings per share

At June 30, 2014, the number of shares outstanding was 172.8 million (June 30, 2013 - 175.0 million).

Basic earnings per share have been calculated using net income for the period divided by the weighted-average number of shares outstanding during the period.

The number of shares used in earnings per share calculations is reconciled as follows:

      For the three months     For the six months
      ended June 30     ended June 30
  (in millions)   2014    2013      2014    2013 
                     
  Weighted-average basic shares outstanding   174.4    174.9      174.9    174.6 
  Dilutive effect of stock options   1.5    1.4      1.6    1.5 
  Weighted-average diluted shares outstanding    175.9    176.3      176.5    176.1 

For the three and six months ended June 30, 2014, there were 124,093 options and 120,930 options, respectively, excluded from the computation of diluted earnings per share because their effects were not dilutive (three and six months ended June 30, 2013 - 5,867 and 55,375, respectively).

6 Assets held for sale

On May 30, 2014, the Company completed the sale of the west end of Dakota, Minnesota and Eastern Railroad ("DM&E West") to Genesee & Wyoming Inc. ("G&W") for net proceeds of U.S. $218 million (CDN $236 million), subject to closing adjustments to be finalized between the Company and G&W in the third quarter of 2014.

7 Shareholders' Equity

On February 20, 2014, the Board of Directors of the Company approved a share repurchase program, and in March 2014, the Company filed a new normal course issuer bid to purchase, for cancellation, up to 5.3 million of its outstanding Common Shares. Under the filing, share purchases may be made during the 12-month period that began March 17, 2014, and ends March 16, 2015. The purchases are made at the market price on the day of purchase, with consideration allocated to share capital up to the average carrying amount of the shares, and any excess allocated to retained earnings.

The following table provides the activities under the share repurchase program:

  For the three months   For the six months
  ended June 30   ended June 30
    2014     2014 
           
Number of common shares repurchased   2,702,232      3,269,982 
Weighted-average price per share(1) $ 176.86    $ 172.90 
Amount of repurchase (in millions)(1) $ 478    $ 565 
(1) Includes brokerage fees.

8  Financial instruments

A.     Fair values of financial instruments

The Company categorizes its financial assets and liabilities measured at fair value in line with the fair value hierarchy established by GAAP that prioritizes, with respect to reliability, the inputs to valuation techniques used to measure fair value. This hierarchy consists of three broad levels. Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets and liabilities and give the highest priority to these inputs. Level 2 and 3 inputs are based on significant other observable inputs and significant unobservable inputs, respectively, and give lower priority to these inputs.

When possible, the estimated fair value is based on quoted market prices and, if not available, estimates from third party brokers. For non-exchange traded derivatives classified in Level 2, the Company uses standard valuation techniques to calculate fair value. Primary inputs to these techniques include observable market prices (interest, foreign exchange and commodity) and volatility, depending on the type of derivative and nature of the underlying risk. The Company uses inputs and data used by willing market participants when valuing derivatives and considers its own credit default swap spread as well as those of its counterparties in its determination of fair value.

The carrying values of financial instruments equal or approximate their fair values with the exception of long-term debt which has a fair value of approximately $5,715 million at June 30, 2014 (December 31, 2013 - $5,572 million) and a carrying value of $4,725 million at June 30, 2014 (December 31, 2013 - $4,876 million). The estimated fair value of current and long-term borrowings has been determined based on market information where available, or by discounting future payments of interest and principal at estimated interest rates expected to be available to the Company at period end. All derivatives and long-term debt are classified as Level 2.

B.   Financial risk management

Derivative financial instruments Derivative financial instruments may be used to selectively reduce volatility associated with fluctuations in interest rates, foreign exchange ("FX") rates, the price of fuel and stock-based compensation expense. Where derivatives are designated as hedging instruments, the relationship between the hedging instruments and their associated hedged items is documented, as well as the risk management objective and strategy for the use of the hedging instruments. This documentation includes linking the derivatives that are designated as fair value or cash flow hedges to specific assets or liabilities on the Consolidated Balance Sheet, commitments or forecasted transactions. At the time a derivative contract is entered into and at least quarterly thereafter, an assessment is made whether the derivative item is effective in offsetting the changes in fair value or cash flows of the hedged items. The derivative qualifies for hedge accounting treatment if it is effective in substantially mitigating the risk it was designed to address.

It is not the Company's intent to use financial derivatives or commodity instruments for trading or speculative purposes.

Foreign exchange management The Company conducts business transactions and owns assets in both Canada and the United States. As a result, the Company is exposed to fluctuations in value of financial commitments, assets, liabilities, income or cash flows due to changes in FX rates. The Company may enter into foreign exchange risk management transactions primarily to manage fluctuations in the exchange rate between Canadian and U.S. currencies. FX exposure is primarily mitigated through natural offsets created by revenues, expenditures and balance sheet positions incurred in the same currency. Where appropriate, the Company may negotiate with customers and suppliers to reduce the net exposure.

Occasionally the Company may enter into short-term FX forward contracts as part of its cash management strategy.

Net investment hedge The FX gains and losses on long-term debt are mainly unrealized and can only be realized when U.S. dollar denominated long-term debt matures or is settled. The Company also has long-term FX exposure on its investment in U.S. affiliates. The majority of the Company's U.S. dollar denominated long-term debt has been designated as a hedge of the net investment in foreign subsidiaries. This designation has the effect of mitigating volatility on net income by offsetting long-term FX gains and losses on U.S. dollar denominated long-term debt and gains and losses on its net investment. The effective portion recognized in "Other comprehensive income" for the three and six months ended June 30, 2014 was an unrealized foreign exchange gain of $119 million and a loss of $12 million, respectively (three and six months ended June 30, 2013 - unrealized foreign exchange loss of $110 million and $177 million, respectively). There was no ineffectiveness during the three and six months ended June 30, 2014 and comparative periods.

Foreign exchange forward contracts The Company may enter into FX forward contracts to lock in the amount of Canadian dollars it has to pay on its U.S. denominated debt maturities.

At June 30, 2014, the Company had no remaining FX forward contracts to fix the exchange rate on U.S. denominated debt maturities. At December 31, 2013, the Company had FX forward contracts to fix the exchange rate on US$100 million of principal outstanding on a capital lease due in January 2014, US$175 million of its 6.50% Notes due in May 2018, and US$100 million of its 7.25% Notes due in May 2019. These derivatives, which were accounted for as cash flow hedges, guaranteed the amount of Canadian dollars that the Company would repay when these obligations mature.

During the three months ended March 31, 2014, the Company settled the FX forward contract related to the repayment of a capital lease due in January 2014 for proceeds of $8 million.

During the three months ended June 30, 2014, the Company de-designated and settled prior to maturity the FX forward contracts related to the repayment of its 6.50% Notes due in May 2018 and its 7.25% Notes due in May 2019 for proceeds of $17 million to be settled in the third quarter of 2014.

During the three and six months ended June 30, 2014, the combined realized and unrealized foreign exchange loss was $8 million and the combined realized and unrealized foreign exchange gain was $3 million, respectively (three and six months ended June 30, 2013 - unrealized gains of $10 million and $15 million, respectively), were recorded in "Other income and charges" in relation to these derivatives. Gains recorded in "Other income and charges" were largely offset by losses on the underlying debt which the derivatives were designated to hedge. Similarly, losses were largely offset by gains on the underlying debt.

At June 30, 2014, the realized gain derived from these FX forwards was $17 million which was recorded in "Accounts receivables" with the offset reflected as realized gains of $3 million in "Accumulated other comprehensive loss" and $14 million in "Retained earnings". At December 31, 2013, the unrealized gains derived from these FX forwards was $25 million of which $6 million was included in "Other current assets" and $19 million in "Other assets" with the offsets reflected as unrealized gains of $5 million in "Accumulated other comprehensive loss" and $20 million in "Retained earnings".

Amounts remaining in "Accumulated other comprehensive loss" at June 30, 2014 will be amortized to "Other income and charges" until the underlying debts which were hedged are repaid.

At June 30, 2014, the Company expected that, during the next twelve months, a pre-tax gain of $1 million would be reclassified to "Other income and charges".

9 Stock-based compensation

At June 30, 2014, the Company had several stock-based compensation plans, including stock option plans, various cash settled liability plans and an employee stock savings plan. These plans resulted in an expense of $39 million for the three months ended June 30, 2014 and an expense of $61 million for the six months ended June 30, 2014 (three and six months ended June 30, 2013, an expense of $10 million and $43 million, respectively).

Regular options In the six months ended June 30, 2014, under CP's stock option plans, the Company issued 375,430 regular options at the weighted-average price of $169.00 per share, based on the closing price on the grant date.

Pursuant to the employee plans, these regular options may be exercised upon vesting, which is between 12 and 48 months after the grant date, and will expire after 10 years.

Under the fair value method, the fair value of the regular options at the grant date was $17 million. The weighted-average fair value assumptions were approximately:

  For the six months
  ended June 30, 2014
       
Grant price $ 169.00
Expected option life (years)(1)   5.83
Risk-free interest rate(2)   1.65%
Expected stock price volatility(3)   28.63%
Expected annual dividends per share(4) $ 1.40
Expected forfeiture rate(5)   1.40%
Weighted-average grant date fair value per regular options      
granted during the period   $46.46
     
(1) Represents the period of time that awards are expected to be outstanding. Historical data on exercise behaviour, or when available, specific expectations regarding future exercise behaviour, were used to estimate the expected life of the option. (2) Based on the implied yield available on zero-coupon government issues with an equivalent remaining term at the time of the grant. (3) Based on the historical stock price volatility of the Company's stock over a period commensurate with the expected term of the option. (4) Determined by the current annual dividend at the time of grant. The Company does not employ different dividend yields throughout the contractual term of the option. (5) The Company estimated forfeitures based on past experience. This rate is monitored on a periodic basis.

Performance share unit ("PSU") plan In the six months ended June 30, 2014, the Company issued 165,390 PSUs with a grant date fair value of approximately $25 million. These units attract dividend equivalents in the form of additional units based on the dividends paid on the Company's Common Shares. PSUs vest and are settled in cash, or in CP common shares approximately three years after the grant date, contingent upon CP's performance ("performance factor"). The fair value of PSUs is measured, both on the grant date and each subsequent quarter until settlement, using a Monte Carlo simulation model. The model utilizes multiple input variables that determine the probability of satisfying the performance factor and market conditions stipulated in the grant.

Deferred share unit ("DSU") plan In the six months ended June 30, 2014, the Company granted 49,846 DSUs with a grant date fair value of approximately $8 million. DSUs vest over various periods of up to 48 months and are only redeemable for a specified period after employment is terminated. An expense for DSUs is recognized over the vesting period for both the initial subscription price and the change in value between reporting periods.

Restricted share unit ("RSU") plan In the six months ended June 30, 2014, the Company granted 15,641 RSUs with a grant date fair value of approximately $3 million. RSUs are subject to time vesting over 36 months. An expense for RSUs is recognized over the vesting period for both the initial subscription price and the change in value between reporting periods.

10  Pensions and other benefits

In the three and six months ended June 30, 2014, the Company made contributions of $20 million and $39 million, respectively (three and six months ended 2013 - $22 million and $52 million, respectively) to its defined benefit pension plans. The net periodic benefit cost for defined benefit pension plans and other benefits recognized in the three and six months ended June 30, 2014 included the following components:

    For the three months
    ended June 30
    Pensions     Other benefits
                       
(in millions of Canadian dollars)   2014      2013      2014      2013 
                       
Current service cost (benefits                      
   earned by employees in the                      
   period) $ 26    $ 33    $   $
Interest cost on benefit obligation   119      111         
Expected return on fund assets   (189)     (187)        
Recognized net actuarial loss   48      68         
Amortization of prior service costs   (17)     (17)        
                       
Net periodic benefit (recovery) cost $ (13)   $   $ 10    $ 12 
                       
    For the six months
    ended June 30
    Pensions     Other benefits
                       
(in millions of Canadian dollars)   2014      2013      2014      2013 
                       
Current service cost (benefits                      
   earned by employees in the                      
   period) $ 53    $ 68    $   $
Interest cost on benefit obligation   238      223      12      11 
Expected return on fund assets   (378)     (373)        
Recognized net actuarial loss   95      134         
Amortization of prior service costs   (34)     (23)        
                       
Net periodic benefit (recovery) cost $ (26)   $ 29    $ 20    $ 22 

11 Contingencies

In the normal course of its operations, the Company becomes involved in various legal actions, including claims relating to injuries and damages to property. The Company maintains provisions it considers to be adequate for such actions. While the final outcome with respect to actions outstanding or pending at June 30, 2014 cannot be predicted with certainty, it is the opinion of management that their resolution will not have a material effect on the Company's financial position or results of operations individually and in aggregate.

Legal proceedings related to Lac-Megantic rail accident On July 6, 2013, a train carrying crude oil operated by Montreal, Maine and Atlantic Railway ("MM&A") derailed and exploded in Lac-Megantic, Quebec on a section of a railway line owned by MM&A. The day before CP had interchanged the train to MM&A, but after the interchange MM&A exercised exclusive control over the train.

Following this incident, the Minster of Sustainable Development, Environment, Wildlife and Parks of Quebec issued an order directing named parties to recover the contaminants and to clean up and decontaminate the derailment. CP was later added as a named party in the administrative action on August 14, 2013.

A class action has also been filed in the Superior Court of Quebec on behalf of a class of persons and entities residing in, owning or leasing property in, operating a business in or physically present in Lac-Megantic. The law-suit seeks damage caused by the derailment including for wrongful deaths, personal injuries, and property damages. CP was added as a defendant on August 16, 2013. In the wake of the derailment and ensuing litigation, MM&A filed for bankruptcy in Canada and the United States.

At this early stage in the legal proceedings, any potential liability and the quantum of potential loss cannot be determined. Nevertheless, CP denies liability for MM&A's derailment and will vigorously defend itself in both proceedings or any proceeding that may be commenced in the future.

Environmental liabilities Environmental remediation accruals cover site-specific remediation programs. The accruals for environmental remediation represent CP's best estimate of its probable future obligation and include both asserted and unasserted claims, without reduction for anticipated recoveries from third parties. Environmental remediation accruals are measured on an undiscounted basis unless a reliably determinable estimate as to amount and timing of costs can be established. The accruals are recorded when the costs to remediate are probable and reasonably estimable. Certain future costs to monitor sites are discounted at a risk free rate. Although the recorded accruals include CP's best estimate of all probable costs, CP's total environmental remediation costs cannot be predicted with certainty. Accruals for environmental remediation may change from time to time as new information about previously untested sites becomes known, environmental laws and regulations evolve and advances are made in environmental remediation technology. The accruals may also vary as the courts decide legal proceedings against outside parties responsible for contamination. These potential charges, which cannot be quantified at this time, are not expected to be material to CP's financial position, but may materially affect income in the particular period in which a charge is recognized. Costs related to existing, but as yet unknown, or future contamination will be accrued in the period in which they become probable and reasonably estimable.

The expense included in "Purchased services and other" for the three and six months ended June 30, 2014 was $nil and $1 million, respectively (three and six months ended June 30, 2013 -$nil and expense of $1 million, respectively). Provisions for environmental remediation costs are recorded in "Other long-term liabilities", except for the current portion which is recorded in "Accounts payable and accrued liabilities". The total amount provided at June 30, 2014 was $89 million (December 31, 2013 - $90 million). Payments are expected to be made over 10 years to 2024.

12  Reclassification of comparative figures

Billings to third parties for the recovery of costs incurred for freight car repairs and servicing have been reclassified from "Purchased services and other" to "Compensation and benefits" and "Materials" within "Operating expenses", in order to match the billings with the costs incurred on behalf of third parties. As a result, the changes to these components of "Operating expenses" for the three and six months ended June 30, 2013 are noted below. "Operating expenses" in total were unchanged as a result of this reclassification.

                  Purchased
      Compensation           services and
(in millions of Canadian dollars)   and benefits     Material     other
                   
For the three months ended June 30, 2013                
As previously reported $ 342    $ 58    $ 246 
(Decrease) increase   (8)     (23)     31 
As reclassified $ 334    $ 35    $ 277 
                   
For the six months ended June 30, 2013                
As previously reported $ 744    $ 130    $ 448 
(Decrease) increase   (18)     (51)     69 
As reclassified $ 726    $ 79    $ 517 

          

          

                      Summary of Rail Data                      
        Second Quarter                         Year-to-date          
  2014      2013      Fav/(Unfav)   %   Financial (millions, except per share data)     2014      2013      Fav/(Unfav)   %
                                             
                      Revenues                        
$ 1,642    $ 1,458    $ 184     13     Freight revenue   $ 3,116    $ 2,917    $ 199   
  39      39         -      Other revenue     74      75      (1)   (1)
  1,681      1,497      184    12   Total revenues     3,190      2,992      198   
                                                   
                                                   
                      Operating expenses                        
  342      334      (8)   (2)    Compensation and benefits(1)     687      726      39   
  273      246      (27)   (11)    Fuel     544      516      (28)   (5)
  47      35      (12)   (34)    Materials(1)     99      79      (20)   (25)
  40      44           Equipment rents     81      90        10 
  137      141           Depreciation and amortization     278      282       
  255      277      22       Purchased services and other (1)     491      517      26   
  1,094      1,077      (17)   (2)   Total operating expenses     2,180      2,210      30   
                                                   
                                                   
  587      420      167    40    Operating income     1,010      782      228    29 
                                                   
                      Less:                        
                                                   
            63      Other income and charges         11        73 
  69      68      (1)   (1)     Net interest expense     139      138      (1)   (1)
                                                   
                                                   
  515      344      171    50    Income before income tax expense     868      633      235    37 
                                               
  144      92      (52)   (57)     Income tax expense     243      164      (79)   (48)
                                                   
                                                   
$ 371    $ 252    $ 119    47    Net income   $ 625    $ 469    $ 156    33 
                                                 
                                                 
  65.1      71.9      6.8  680  bps   Operating ratio (%)     68.3      73.9      5.6  560  bps
                                                   
                                                   
$ 2.13    $ 1.44    $ 0.69    48      Basic earnings per share   $ 3.57    $ 2.68    $ 0.89    33 
                                                   
                                                   
$ 2.11    $ 1.43    $ 0.68    48      Diluted earnings per share   $ 3.54    $ 2.66    $ 0.88    33 
                                                 
                      Shares Outstanding                        
                                                   
                        Weighted average number of shares                        
  174.4      174.9      (0.5)       outstanding (millions)     174.9      174.6      0.3   
                                               
                        Weighted average number of diluted shares                        
  175.9      176.3      (0.4)       outstanding (millions)     176.5      176.1      0.4   
                                                   
                      Foreign Exchange                        
                                                   
                          Average foreign exchange rate                        
  0.91      0.98      0.07    7       (US$/Canadian$)     0.91      0.99      0.08   
                                                 
                         Average foreign exchange rate                        
  1.10      1.02      0.08        (Canadian$/US$)     1.10      1.01      0.09   
                                             
(1) Billings to third parties for the recovery of costs incurred for freight car repairs and servicing have been reclassified from Purchased services and other to Compensation and benefits and Materials within Operating expenses.
                                             
                      Summary of Rail Data                      
        Second Quarter                 Year-to-date          
  2014      2013      Fav/(Unfav)   %         2014      2013     Fav/(Unfav)   %
                                             
                      Commodity Data                      
                                                 
                        Freight Revenues (millions)                      
$ 252    $ 191    $ 61    32        - Canadian Grain   $ 473    $ 394    $ 79    20 
  115      91      24    26        - U.S. Grain     221      202      19   
  165      144      21    15        - Coal     313      293      20   
  101      95              - Potash     181      177       
  64      68      (4)   (6)       - Fertilizers and sulphur     118      138      (20)   (14)
  52      53      (1)   (2)        - Forest products     100      106      (6)   (6)
  155      138      17    12        - Chemicals and plastics     302      277      25   
  114      97      17    18        - Crude     218      189      29    15 
  170      144      26    18        - Metals, minerals, and consumer products     331      285      46    16 
  104      106      (2)   (2)       - Automotive     192      203      (11)   (5)
  200      171      29    17        - Domestic intermodal     377      341      36    11 
  150      160      (10)   (6)       - International intermodal     290      312      (22)   (7)
                                                 
$ 1,642    $ 1,458    $ 184    13    Total Freight Revenues   $ 3,116    $ 2,917    $ 199   
                                                 
                      Millions of Revenue Ton-Miles (RTM)                      
  7,074      5,272      1,802    34        - Canadian Grain     12,920      10,647      2,273    21 
  2,679      2,411      268    11        - U.S. Grain     5,218      5,466      (248)   (5)
  5,941      5,316      625    12        - Coal     11,382      10,956      426   
  4,114      4,254      (140)   (3)       - Potash     7,407      7,890      (483)   (6)
  1,130      1,352      (222)   (16)       - Fertilizers and sulphur     2,204      2,668      (464)   (17)
  1,003      1,267      (264)   (21)       - Forest products     1,923      2,490      (567)   (23)
  3,326      3,435      (109)   (3)       - Chemicals and plastics     6,532      6,969      (437)   (6)
  3,816      3,640      176          - Crude     7,174      7,131      43   
  2,698      2,339      359    15        - Metals, minerals, and consumer products     5,411      4,850      561    12 
  597      629      (32)   (5)       - Automotive     1,111      1,233      (122)   (10)
  3,003      2,546      457    18        - Domestic intermodal     5,637      5,064      573    11 
  3,048      3,530      (482)   (14)       - International intermodal     5,885      6,790      (905)   (13)
                                                 
  38,429      35,991      2,438      Total RTMs     72,804      72,154      650   
                                                 
                      Freight Revenue per RTM (cents)                      
  3.56      3.61      (0.05)   (1)       - Canadian Grain     3.66      3.69      (0.03)   (1)
  4.31      3.77      0.54    14        - U.S. Grain     4.24      3.70      0.54    15 
  2.79      2.70      0.09          - Coal     2.75      2.67      0.08   
  2.46      2.24      0.22    10        - Potash     2.44      2.24      0.20   
  5.61      5.01      0.60    12        - Fertilizers and sulphur     5.35      5.16      0.19   
  5.20      4.20      1.00    24          - Forest products     5.19      4.26      0.93    22 
  4.67      3.98      0.69    17        - Chemicals and plastics     4.63      3.94      0.69    18 
  2.99      2.67      0.32    12        - Crude     3.04      2.65      0.39    15 
  6.27      6.22      0.05          - Metals, minerals, and consumer products     6.11      5.92      0.19   
  17.37      16.87      0.50          - Automotive     17.31      16.49      0.82   
  6.66      6.72      (0.06)   (1)       - Domestic intermodal     6.69      6.73      (0.04)   (1)
  4.94      4.52      0.42          - International intermodal     4.93      4.60      0.33   
                                                 
  4.27      4.05      0.22      Total Freight Revenue per RTM     4.28      4.04      0.24   
                                                 
                      Summary of Rail Data                      
        Second Quarter                     Year-to-date          
  2014      2013      Fav/(Unfav)   %         2014     2013     Fav/(Unfav)   %
                                             
                      Carloads (thousands)                      
  78      61      17    28       - Canadian Grain     140      120      20    17 
  44      42             - U.S. Grain     83      91      (8)   (9)
  82      75             - Coal     160      156       
  33      35      (2)   (6)      - Potash     61      65      (4)   (6)
  16      19      (3)   (16)      - Fertilizers and sulphur     31      38      (7)   (18)
  15      18      (3)   (17)      - Forest products     29      36      (7)   (19)
  49      48             - Chemicals and plastics     94      99      (5)   (5)
  25      24             - Crude     49      46       
  60      58             - Metals, minerals, and consumer products     116      112       
  37      38      (1)   (3)      - Automotive     67      73      (6)   (8)
  110      93      17    18       - Domestic intermodal     207      182      25    14 
  140      157      (17)   (11)      - International intermodal     270      309      (39)   (13)
                                                 
  689      668      21      Total Carloads     1,307      1,327      (20)   (2)
                                                 
                      Freight Revenue per Carload                      
$ 3,219    $ 3,127    $ 92          - Canadian Grain   $ 3,374    $ 3,271    $ 103   
  2,645      2,159      486    23        - U.S. Grain     2,675      2,225      450    20 
  2,027      1,921      106          - Coal     1,963      1,878      85   
  3,046      2,706      340    13        - Potash     2,983      2,719      264    10 
  3,925      3,609      316          - Fertilizers and sulphur     3,770      3,593      177   
  3,502      2,998      504    17        - Forest products     3,452      2,944      508    17 
  3,185      2,809      376    13        - Chemicals and plastics     3,213      2,759      454    16 
  4,524      4,095      429    10        - Crude     4,452      4,122      330   
  2,810      2,537      273    11        - Metals, minerals, and consumer products     2,839      2,571      268    10 
  2,798      2,759      39          - Automotive     2,850      2,751      99   
  1,822      1,839      (17)   (1)       - Domestic intermodal     1,825      1,877      (52)   (3)
  1,074      1,017      57          - International intermodal     1,074      1,011      63   
                                                 
$ 2,383    $ 2,183    $ 200      Total Freight Revenue per Carload   $ 2,384    $ 2,198    $ 186   
                                             
                      Summary of Rail Data                       
  Second Quarter           Year-to-date
  2014      2013(1)     Fav/(Unfav)   %         2014      2013(1)     Fav/(Unfav)   %
                                             
                      Operations Performance                      
                                             
  71,333      67,232      4,101      Freight gross ton-miles (millions)     133,682      134,910      (1,228)   (1)
  38,429      35,991      2,438      Revenue ton-miles (millions)     72,804      72,154      650   
  9,335      9,645                   310      3    Train miles (thousands)     18,062      19,639                1,577        8 
  8,178      7,471      707      Average train weight - excluding local traffic (tons)     7,924      7,337      587   
  6,880      6,444      436      Average train length - excluding local traffic (feet)     6,634      6,369      265   
  8.6      6.8      (1.8)   (26)   Average terminal dwell  - (hours)(2)     9.4      6.7      (2.7)   (40)
  18.1      18.6      (0.5)   (3)   Average train speed - (mph)(3)     17.1      18.4      (1.3)   (7)
                                             
  228.6      218.0      10.6      Locomotive productivity (daily average GTMs/active HP)     216.5      211.5      5.0   
                                             
  1.00      1.05      0.05      Fuel efficiency(4)     1.05      1.09      0.04   
  70.3      69.8      (0.5)   (1)   U.S. gallons of locomotive fuel consumed (millions)(5)     138.7      145.6      6.9   
  3.53      3.45      (0.08)   (2)   Average fuel price (U.S. dollars per U.S. gallon)     3.58      3.50      (0.07)   (2)
                                             
  14,787      15,471      684      Total employees (average)(6)     14,516      15,196      680   
  14,736      15,355      619      Total employees (end of period)(6)     14,736      15,355      619   
  14,960      16,053      1,093      Workforce (end of period)(7)     14,960      16,053      1,093   
                                             
                      Safety                      
                                             
  1.84      1.51      (0.33)   (22)   FRA personal injuries per 200,000 employee-hours     1.73      1.62      (0.11)   (7)
  1.03      1.94      0.91    47    FRA train accidents per million train-miles     1.08      1.95      0.87    45 

(1)   Certain prior period figures have been revised to conform with current presentation or have been updated to reflect new information.
(2)  Incorporates a new reporting definition where average terminal dwell measures the average time a freight car resides within terminal boundaries.
(3)   Incorporates a new reporting definition where average train speed measures the line-haul movement from origin to destination including terminal dwell hours.
(4)  Fuel efficiency is defined as U.S. gallons of locomotive fuel consumed per 1,000 GTMs - freight and yard.
(5)  Includes gallons of fuel consumed from freight, yard and commuter service but excludes fuel used in capital projects and other non-freight activities.
(6)   An employee is defined as an individual, including trainees, who has worked more than 40 hours in a standard biweekly pay period.  This excludes part time employees, contractors, and consultants.
(7)   Workforce is defined as total employees plus part time employees, contractors, and consultants.

 

SOURCE Canadian Pacific

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